Should Indians Stop Buying Gold?

Posted in Finance Articles, Total Reads: 1860
, Published on 18 January 2014

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The yellow metal is making more of waves in the economy for the past six months or even more. What more to say?? Gold is losing its importance all over the markets and predominantly in India from the economic front. The entire story of this glittering metal started many decades ago when countries traded with each other under the Gold Standards. That is, the value of a country’s currency depended upon the amount of gold reserves with them. If India and the United States are on the gold standard, the rupee being equal to 1 grain of gold and the dollar 60 grains of gold, the rate of exchange between these two countries will be, One Dollar = Rs. 60/-. The situation changed after the World War I, when America was depleted of its gold reserves to a great extent.

The Americans on a clever note, brought into effect the Nixon Shock in 1971 which was a series of economic measures taken by the then President, Richard Nixon. The measures included unilaterally cancelling the direct convertibility of the United States dollar to gold. Thus free floating currency system was born and the United States committed itself by backing every dollar overseas with gold. Other currencies were fixed with respect to the dollar and the dollar was pegged to gold. From then on, the dollar became the dominating currency in the world. Every country has its currency valued against the dollar. Most importantly, the US also realised that in the upcoming generation petrol will be as valuable as gold. Thus they signed an agreement with the Middle East countries to sell petrol in dollars only; in return the Americans will protect the kings and their heirs. This method, called derivative trading put an extra pressure on the developing countries in possessing dollar reserves to satisfy their crude oil needs. Such was the condition prevailing in the markets about three to four decades ago and the dollars were getting a cemented place in the developing countries market.

Image Courtesy: freedigitalphotos.net, pakorn

Coming to India and its fascination for the yellow metal, Gold is the second highest imported commodity in India after crude oil. China and India have dominated the jewellery demand in the second quarter of this fiscal year 2013-2014, with 60% of demand arising from these two countries. So what is the problem in being attracted to gold? Gold can be used in two ways. As a commodity, to buy or sell the trader puts demand and supply issues at the forefront. In insurance point of view, gold is helpful in extreme cases of hyperinflation where paper currency would hold lesser value than gold. The actual problem is that, investing in gold is not a real investment unlike those of stocks and bonds. In the latter case, the value of the investment can be done by the cash flows throughout the holding period. While, on the other hand, gold is worth of what the investor is ready to pay or by the mood of the investors. It can either plummet low or soar high. There are no dividends or capital gains with the same. Unknowing of this fact, people buy gold and stock it in the bank lockers with a momentary desire that it the price keeps rising. Gold price has risen from about $350 to $1800 in the last ten years. At the same time, prices have started to fall for the past two years. Hence, it is not always a reliable appreciating asset.

Investing in gold can be of many forms – Gold jewellery, Gold bars and Gold coins. Gold jewellery is the only major industrial use of the asset. This trend too is declining with people considering it as old fashioned. Gold jewellery is hard to be seen nowadays except at marriage halls and few special occasions. Buying gold bars will prove futile since the cost of safe-guarding it can be very heavy. Purchasing gold coins can be convenient but it involves paying a markup over the asset value of the gold, with extra liquidation costs at the time sale.

Scenarios many have changed in the way of handling gold, leading to its decreased necessity on the economic front. Paying for crude oil imports has also changed from gold to dollars. Gold has lost its major glory in this case. Indian current account deficit (CAD) also increases a manifold because of gold. This statement has two connotations. One is that being imported on a very high scale, gold widens the trade gap. The other, buying gold depletes the forex reserves in India since India has to pay in dollars for every import transaction carried out. Hence amount of dollars available in India decreases which correspondingly has an impact on the Rupee. The Rupee depreciates against the dollar since the supply of dollars becomes limited. Considering all these problems at hand, the RBI has taken an exclusive stream of measures to contain the CAD. It has hiked the import duty on gold to 15% gradually. Measures for investment in gold other than physical form like ETF’s (Exchange Traded Funds) have also come up for user convenience.

All these measures can deter gold imports for a short term but in most of the cases, traders stock gold on a large scale basis and then release the same into the market slowly. Such black-marketing practices can also inflate the prices causing instability in the economy. Smuggling gold has also become common these days especially due to such kind of volatility in prices and government measures. These kinds of practices make the yellow metal available to consumers preventing any shortage even during any duty hike or government rule against this commodity.

However the main concern is not about buying gold. It’s about buying gold “now”. People must resist buying gold temporarily. It’s most certain that people will surely benefit the least investing now. It’s not that people must leave their flair for this metal as such in this short term. They can buy gold. Nevertheless the same should be done in a small and systematic manner i.e. by the way of Small Investment Plan. In other words, people can buy gold which accounts for less than 10% of their investments. The CAD has to be curtailed to a minimal extent and this can be aided by limiting the purchase of Gold. Consumers should thus be taught the consequences of their purchase by campaigns and heavy promotions. It can surely make them do their purchases periodically preventing a heavy surge in demand straightaway.

Concluding, gold can give a different meaning to every consumer. Options available in it are plenty. Even though it’s monetary standards were as high as the US dollar as today, the functional aspect of this metal has lessened to a great extent with the industrial demand being less than 10%. Thus, as of today, it does not seem as a brighter investment option on the whole, spending the entire savings on it. People can use it as insurance to a certain extent, provided the investment option comes as a price which is worth it.

This article has been authored by Soundarya.R from SSN School of Management